Think Tank: The 'Wonga model' can open the door to new business lending

The uproar over payday lender Wonga's move to offer short-term loans to
businesses has turned the spotlight on the growing role of alternative
funders in providing much needed finance to SMEs.

One of the key fears raised by Wonga's entrance into the market is the level of interest rates charged by alternative funders.

By Rachel Bridge

9:45PM BST 26 May 2012

In the past two years, several new internet-based finance providers have emerged to plug the gap left by the high street banks in providing finance to small firms. Most are based on the concept of crowd funding – gathering small amounts from a large number of individuals – and their rapid growth has shown how much their presence was needed.

Funding Circle, for example, is currently lending more than £1m a week to small businesses, raising the money from private individuals who can lend a minimum of just £20. Since it was launched in 2010, Funding Circle has lent a total of £32m to 750 firms.

Crowdcube, which enables individuals to invest from £10 in a small business in return for a slice of equity, is much smaller – so far providing £2.8m in funding to 18 firms – but it, too, has proved that its concept works. Bodycare products business Bubbles and Balm, for example, raised £75,000 this way in return for relinquishing 15pc equity.

Other new entrants to the business market include peer-to-peer lender Massow's Angels and Zopa, which lends to private individuals who can then use the money for business purposes.

One of the key fears raised by Wonga's entrance into the market is the level of interest rates charged by alternative funders – Wonga has caused great concern with its plans to charge up to 2pc a week for its loans, equal to an annualised rate of close to 200pc.

This compares with interest rates on bank loans which are a fraction of that – RBS for example charges less than 4pc a year excluding fees for its loans to small businesses.

Alternative funders do generally charge more than banks but the numbers vary - loans through Funding Circle, for example, carry an average interest rate of 8.4pc a year.

The Government has broadly welcomed the emergence of alternative funders, and invites the key players for discussions.

Mark Prisk, the Business and Enterprise minister, has spoken about the importance of businesses having access to a diverse range of finance sources and the Government recently announced that £100m from its Business Finance Partnership scheme for investment in SMEs will be allocated through non-bank lending channels.

However, if it is serious about encouraging the growth of a genuine long-term alternative to bank lending for SMEs, the Government also needs to address the thorny question of regulation. At present, alternative funding providers are not regulated by existing financial services legislation, leaving both borrowers and lenders vulnerable to rogue players entering the market.

In the absence of formal regulation, the alternative funders have started regulating themselves, setting up trade bodies such as Next Generation Finance Consortium and Peer to Peer Finance Association, which sets out a list of suggested operating principles.

The alternative funders are in favour of greater government regulation of the sector, believing that legislated guidelines and a code of practice with teeth will reassure lenders, give the industry greater credibility and ensure that new entrants adhere to the same standards they do.

Samir Desai, co-founder of Funding Circle, said: "We definitely welcome regulation. It would put in place minimum standards for competitors coming into the market which would protect customers and increase confidence in the sector."

Darren Westlake, co-founder of Crowdcube, agreed, saying: "Having that stamp of approval to know that you are dealing with a reputable firm is a great way to give credibility and reassurance to investors."

The Government is, for now, maintaining a watching brief on the situation. But SMEs desperately need a genuine alternative to borrowing from banks and those using alternative funders must be protected so that both they and the market can flourish.

Rachel Bridge is an author and journalist specialising in entrepreneurship.